I. Auditor’s Opinion

Auditor’s Opinion

To Zhejiang World Bank Loan Afforesting Project Leading Group Office

We have audited the special purpose financial statements (from page 6 to page 31) of Zhejiang Integrated Forestry Development Project financed by the World Bank, which comprise the Balance Sheet as of December 31, 2014, the Summary of Sources and Uses of Funds by Project Component, the Statement of Implementation of Loan Agreement and the Special Account Statement for the year then ended, and Notes to the Financial Statements.

The preparation of the Balance Sheet, the Summary of Sources and Uses of Funds by Project Component and the Statement of Implementation of Loan Agreement is the responsibility of your entity, while the preparation of the Special Account Statement is the responsibility of Zhejiang Provincial Finance Department, which includes:

ⅰ.Preparing and fair presenting the accompanying financial statements in accordance with Chinese accounting standards and system, and the requirements of the project loan agreement;

ⅱ.Designing, implementing and maintaining necessary internal control to ensure that the financial statements are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the Government Auditing Standards of the People’s Republic of China and International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entities’ preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is appropriate and sufficient to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements identified in the first paragraph present fairly, in all material respects, financial position of Zhejiang Integrated Forestry Development project financed by the World Bank as of December 31, 2014, its financial receipts and disbursements, the project implementation and the receipts and disbursements of the special account for the year then ended in accordance with Chinese accounting standards and system, and the requirements of the project loan agreement.

Other Matter

We also examined the withdrawal application No.ZJ07, No.ZJ08, No.ZJ09 and the attached documents submitted to the World Bank during the period. In our opinion, those documents comply with the project loan agreement and can serve as basis for loan withdrawal.

The audit report consists of the Auditor’s Opinion and two more parts hereinafter: Financial Statements and Notes to the Financial Statements, Audit Findings and Recommendations.

v .Notes to the Financial Statements

Notes to the Financial Statements

1. Project Overview

Zhejiang“Integrated Forestry Development Project”, Loan No. 7939-CN, aims to improve stand structure of the project area, forest land’s vegetation cover and enhance the area’s forest ecological function through reforestation and ecological operation of low-function forests. The project construction area covers 244,612,000 hectares, distributing in four counties (cities): Lin'an, Deqing, Fuyang and Anji, covering 50 townships (towns), 239 administrative villages and 14,455 farmers. The project agreement was signed on August 13, 2010 and came into effect after 90 days. The closing date of accounting is expected to be on December 31, 2016. The total investment of this project reaches RMB285,607,000 yuan, of which USD21,000,000 belongs to World Bank loan (including 0.25% front-end fee), equivalent to RMB142,800,000 yuan (USD1 = RMB 6.8 ), accounting for 50% of the total investment; domestic funds covers RMB142,807,000 yuan, accounting for 50% of the total investment.

2. Consolidation Scope of the Financial Statements

Consolidation scope of these Financial Statements includes Zhejiang World Bank Loan Afforesting Project Leading Group Office, Financial Statements of four counties’ project offices and Special Account Statements of Provincial Department of Finance.

3. Principal Accounting Policies

3.1 The preparation of Financial Statements for this project is in accordance with the requirement of Accounting Methods of World Bank Financed Projects (Caijizi No.〔2000〕13).

3.2 In accounting practice, the Gregorian calendar year is adopted as the fiscal year from January 1 to December 31.

3.3 All accounting transactions are processed on accrual basis and by double entry bookkeeping system. RMB is adopted as functional currency. The year’s adjustment and accounting of exchange gain or loss shall be based on the currency rate at the day of December 31, 2014 of the People’s Bank of China, that is USD1=RMB 6.1190 yuan.

4. Explanatory Notes to the account title of the Statements

4.1 Project Expenditures

The project expenditure in 2014 is RMB 19,508,164.93 yuan, and cumulative expenditure of the project is RMB 201,049,189.94 yuan, accounting for 70.39% of the total investment plan.

4.2 Cash and Bank

The ending balance is RMB 16,679,948.76 yuan, of which the special account deposit is USD 229,698.20, equal to RMB 1,405,523.28 yuan.

4.3 Prepayments and Receivables

The beginning balance is RMB 9,944,176,07 yuan, and the ending balance is RMB 29,458,542.72 yuan, which mainly is the project’s County (City) construction prepayment.

4.4 Total Project Appropriation Funds

The beginning balance is RMB 99,780,861.60 yuan, and the ending balance is RMB 121,357,160.44 yuan, which is in-place counterpart funds on province, city and county level, accounting for 84.98% of the total amount of planned project counterpart funds (RMB 142,804,400.00 yuan): the total amount of planned provincial level counterpart funds is RMB 28,560,000 yuan, and cumulative in-place amount is RMB 24,018,400.00 yuan, accounting for 84.10% of the plan; the total amount of planned county level counterpart funds is RMB 57,122,200.00 yuan, and cumulative in-place amount is RMB 53,611,779.20 yuan, accounting for 93.85% of the plan; the total amount of planned self-raised counterpart funds is RMB 57,122,200.00 yuan, and cumulative in-place amount is RMB 43,726,981.24 yuan, accounting for 76.54% of the plan.

4.5 Total Project Investment Loan

The ending balance is RMB 107,157,374.04 yuan, equaling to USD 17,512,236.32 (including the frond-end fee of USD 52,500), which is the loan granted by International Bank for Reconstruction and Development, and takes up 83.39% of total World Bank loan (USD 21,000,000).

4.6 Payables

The beginning balance is RMB 41,089,041.51 yuan, and the ending balance is

RMB 18,340,072.62 yuan, which mainly is project construction payables of every county (city).

4.7 Retained Earnings

The ending balance is RMB 333,074.32 yuan, mainly interest revenue of the account.

5.Status of the Special Account

The special account of this project is opened in USD with Business Department of Construction Bank Zhejiang Branch, and the account is No.33014000300229000788. The beginning balance of year 2014 of the special account is USD 636,959.22. With the supplement of USD 4,353,921.40 and the payment of USD 4,761,182.42 in the year, the ending balance is USD 229,698.20.

6. Project Progress

6.1 Forest Restoration

6.1.1 Implementation status of afforestation and tending

By the end of 2014, the cumulative eco-restoration area is 21,972.69 hectares (“ha.”), taking up 89.83% of the planned area (24,461.20 ha.), of which, the area of coniferous and broad-leaf forest is 8,489.09 ha., accounting for 89.63% of the plan (9,471.20 ha.); the area of bamboo, coniferous and broad-leaf forest is 1,151.30 ha., accounting for 94.52% of the plan (1218 ha.); the area of Chinese fir and broad-leaf forest is 5,252.60 ha., accounting for 87.69% of the plan (5,990 ha.); the area of Chinese fir, bamboo and broad-leaf forest is 4,112.63 ha., accounting for 88.71% of the plan (4,636 ha.); the area of chestnut and broad-leaf forest is 2,046.64 ha., accounting for 91.45% of the plan (2,238 ha.); and the area of tea and broad-leaf forest is 920.43 ha., accounting for 101.36% of the plan (908 ha.).

In 2014, the actual eco-restoration area is 2024.86 ha., taking up 69.8% of the annual planned area, of which, the area of coniferous and broad-leaf forest is 840.73 ha., accounting for 57.60% of the plan; the area of Chinese fir and broad-leaf forest is 594.13 ha., accounting for 82% of the plan; the area of Chinese fir, bamboo and broad-leaf forest is 250 ha., accounting for 66.80% of the plan; the area of chestnut and broad-leaf forest is 247.6 ha., accounting for 100% of the plan; and the area of tea and broad-leaf forest is 92.40 ha., accounting for 100% of the plan.

In 2014, the actual tending area is 6,061.53 ha., taking up 100% of the annual planned area, of which, the area of coniferous and broad-leaf forest is 2,699.46 ha., the area of bamboo, coniferous and broad-leaf forest is 328.90 ha., the area of Chinese fir and broad-leaf forest is 1,271.47 ha., the area of Chinese fir, bamboo and broad-leaf forest is 1,001.03 ha., the area of chestnut and broad-leaf forest is 533.34 ha.,and the area of tea and broad-leaf forest is 227.33 ha.

According to provincial inspection result, in 2014, the rate of checked-area is 100%, the utilization rate of first-grade seedlings (being container seedlings) is 100%, the pass percent of replanting is over 97%, the average survival rate of afforestation is 94.0%, and the percent of pass of environment protection measures is 96.0%.

6.1.2 Use of seedlings.

Each county/city has established or determined a fixed seedling nursery to provide seedlings and signed contract for such supply. The planted seedlings are high-quality container-grown seedlings, mainly including Phoebe chekiangensis, Chinese sweet gum, gingko, Schima superba, Betula luminifera, Zelkova serrate, photinia serrulata, sassafrases, etc. As of Dec. 31 of 2014, 9.3831 million seedlings are used to restore existing forest, accounting for 115.5% of the cumulative annual plan (8.1223 million). In 2014, 980.7 thousand seedlings are used.

6.1.3 Use of fertilizers.

To protect and improve soil quality, we manage to use organic fertilizers and not to use compound fertilizers as much as possible. As of Dec. 31 of 2014, altogether 2,797.10 tons of fertilizers have been used, of which, 1,888.44 tons are organic fertilizers and 908.66 tons are compound fertilizers

6.1.4 Use of pesticides

We advocate the principle of the fewer pesticides, the better. No pesticides are used because no serious disease or pest occurs during implementation of this project.

6.2 Support of Forest Reform and Organization Institutions, Monitoring and Evaluation

Chinese Torreya Cooperatives. Local project office has provided the Cooperatives with computer, printer, office tables and chairs, and other office equipment and technology dissemination materials to dramatically improve its hardware.

Besides, considering the cooperatives are faced with such problems as small fund and scale, and weak ability to meet market demand at the beginning, the county/city forestry bureaus have given more support to them. First, local government makes active publicity work to attract more farmers to make investment or contribution to improve size of cooperatives. Second, local government provides relevant technical trainings, technical guidance, information sharing and other services. The county/city forestry bureaus/agriculture bureaus shared resources with each other—in addition to organizing cooperatives to participate in various trainings, the forestry bureaus have invited experts with the agriculture bureaus to give lectures so as to actively expand the scope of training. Third, actively promote standard management of cooperatives. County/City Project Offices have actively invited experts with competent authorities to help the cooperatives build and improve rules and regulations, with an aim to enhance their management level and facilitate their sustainable and sound development.

6.2.2 Promotion of practical technologies

During the process of forestry right reform, it is necessary to provide members of farmer associations and farmers with large amount of professional trainings on such aspects as establishment and management of cooperatives, relevant laws and regulations, forestry technologies and expertise, etc. In response to these needs, the County/City Project Offices have, based on local actual situation, actively organized trainings to promote practical technologies, and sent the following materials to implementing units and nursery units: cultivation technique manual, seedling growing manual, forestry technology guide, and other practical books and materials.

6.2.3 Related researches progressed as planned

6.2.3.1 Forestry right reform practice and research work

The work is taken charge of by Zhejiang A&F University. Related researches have been completed and the research report has been submitted to the World Bank Loan Project Management Center for review. At the technical training held by the management center in Nov. 2014, researchers responsible for the project introduced research achievements.

The research takes Anjie forestland transfer as an example to make an in-depth research. The content of research includes: a. Development and current condition of Anji forestry right reform; motivations and current condition of Anji forestland transfer (defects of scattered and small-scale operation by farmers, driving force of Anji social economy, and driving force of relevant incentive policies on forestland transfer); b. Analysis of the characteristics of Anji forestland transfer—based on farmer survey; analysis of Anji forestland transfer mode (transferring from farmer operation to large family (family forestry center) operation, company operation and stock Cooperatives operation); c. Analysis of the effect of Anji forestland transfer (realize scale operation of forestland, improve forestry infrastructure, optimize the configuration of forest resources, promote standard production and brand operation of forestry, improve the competitiveness of forest products, improve employment of labor forces in rural area, and increase the income of farmers); d. Main problems with Anji forestland transfer (nonstandard forestland transfer, low price, large area and long tenure, and forest flipping and speculation); e. Countermeasures (standardize forestland transfer to protect the legitimate rights and benefits of the group and farmers; promote stock transfer of forestland land to prevent farmers from losing their forest and land; strengthen the building of forestland transfer service system to create a favorable environment for forestland transfer).

6.2.3.2 Forestry integrated development assessment research

The work is taken charge of by Research Institute of Asian Forestry under Chinese Academy of Forestry, which has, in accordance with research content and requirements, organized the expert team to collect basic data, including field investigation and collection of existing data. According to the plan, the research report is under preparation and will be submitted in 2015.

6.2.3.3 Ecological restoration comprehensive technology research

The work is taken charge of by Anji County, which has entrusted Zhejiang Forestry Academy to do the research. At present, the academy is preparing the research syllabus.

6.2.3.4 The function and service mode of farmer cooperatives research

Research on the function and service mode of farmer cooperatives is taken charge of by Lin’an City. At present, the research task syllabus and research report draft have been completed. The main research content is as follows: a. Demand analysis of farmer social service : Take farmers’ demand into consideration while building social service system. By conducting questionnaire survey among

farmer members, analyze their social service demands, mainly including demand for technology, information, agricultural materials, product acquisition and sales, capital lending, asset valuation, forestry right mortgage loan, policy-based insurance, credit cooperatives and other demands, access channel and satisfaction degree. b. Function analysis of cooperatives service: By means of literature review, secondary data collection, key informant interviews and cooperatives research, analyze the development process, status quo and trends of cooperatives in Lin’an City, and the effect of existing cooperatives technical information service, unified provision of agricultural materials, unified purchase and sales of products, capital lending, forestry rights play situation mortgage loan, forestry insurance, credit cooperatives, etc. c. Cooperatives service mode and applicable conditions: Based on researches among and recommendations of Lin’an Agriculture Office, Agriculture Bureau, Forestry Bureau and so on, select typical cooperatives to conduct in-depth research, summarize the typical service mode of Lin’an cooperatives, and analyze the applicable conditions so as to facilitate promotion of the corresponding service mode and to better serve development of modern agriculture and income increase of farmers.

6.2.4 Implementation of forest management plan

According to the Forest Management Plan Preparation Syllabus stipulated based on project implementation plan, under the guidance of Zhejiang Forestry Academy, Anji Forestry Bureau accomplished the preparation of the management plan for 100-ha forest in 2012. The form report was submitted to the project center of State Forestry Administration in Dec., 2012.

To strictly carry out the plan, Anji County Project Office has invited experts to give onsite technical guidance at the pilot area, and carried out the following work:

Second, carry out measures (leveling off hilltops and fertilizing) to cultivate the 10 compartments of Chinese fir and coniferous forest, with an aim to cut down sick, dead and aged trees, and maintain native broad-leaf saplings of great potential;

Plan demonstration effect:At the project, “Forest Management Plan Demonstration Point”, the ecological management style and philosophy of environmental protection has achieved a relatively good result at local, which has not only expanded the scope of community awareness of sustainable management, but also give full play of the project “demonstration” role in environment-friendly, sustainable development etc..

6.2.5 Monitoring and assessment

The eco-environment and social & economic achievements monitoring consists of 4 sub-projects, including 3 sub-projects for monitoring eco-environment achievements (Zhejiang Province Soil Erosion and Surface Runoff Monitoring, Zhejiang Province Plant Diversity and Vegetation Coverage Monitoring, and Zhejiang Province Forest Disease and Pest Monitoring conducted by Zhejiang Forestry Academy) and one sub-project for monitoring social & economic achievements (Zhejiang Province Project Participants, Income Growth and Employment Opportunity Monitoring conducted by Zhejiang A&F University). At present, the monitoring goes well. It will continue to carry out the monitoring tasks as planned in the next step, and make timely reimbursement based on completion of monitoring tasks.

Fixed monitoring sites are established for three ecological environment monitoring projects in the four counties (cities) respectively, so as to on a regular base observe and record occurrence of forest disease and pest, change in plant diversity and vegetation coverage, and to record precipitation, runoff volume and other indices by using advanced devices, such as automatic water level indicator and rain gauge. Preliminary monitoring result shows that average runoff volume and soil loss volume is lower than the comparison value, the rate of arbor canopy density, shrubs coverage and weighted average of plant variety are higher than the comparison value, and occurrence rate of disease and pest is low.

Socioeconomic monitoring data shows that the project has provided more employment opportunities for local farmers, and increased their labor income and living conditions.

6.2.6 Technical training.

According to the requirements of “Forestry Integrated Development Project” Technical Training and Promotion Plan and actual demands, Zhejiang Province has organized various trainings for project manager, technicians and foresters. The provincial trainings are dedicated for county-level project managerial staff and technicians, and the county- and village-level trainings are dedicated for village-level and grassroots managerial staff, technicians and implementing units. The trainings focus on attendance negotiation, forestland selection, mixed forest building technology, existing forest operation and management technology, environment protection, seedling growing and nursery management, forest disease and pest prevention and control, project management, quality control, fund and financial management, fund withdrawal and reimbursement, acceptance check, use of financial software and so on.

As of Dec. 31, 2014, we have organized 126 man-day offshore visits (6 men per day, and 21 days altogether), accounting for 90% of the plan (140 man-day). In Jan. and Feb. of 2015, we have organized 10 project managerial staff and technicians to attend the 21-day training inBrazil(210 man-day). As of today, we have altogether organized 336 man-day offshore visits, equal to 240% of the plan (140 man-day). The cumulative provincial training is 344 man-day, accounting for 77.10% of the total plan (446 man-day). The cumulative county- and village-level training is 35,994 man-day, accounting for 86.50% of the total plan (41,618 man-day), of which, the county- and village-level training completed in 2014 is 8,331 man-day, with the training for male is 5,234 man-day (62.80%) and the training for female is 3,097 man-day (37.20%).?xml:namespace>

7. Implementation of Other Matters Agreed on with the World Bank

7.1 According to the requirements of the World Bank inspection memo and the World Bank Loan Project Management Center , we have sorted out information on implementation progress and capital expenditure of Part C and prepared Report on Implementation of Part C of the Zhejiang Integrated Forestry Development Project Financed by the World Bank, which has been submitted.

7.2 According to the requirement of “accurate records of actual investment and fund resource in afforestation” specified in the check memo 2014, we have promptly arranged afforestation investment record pilot work, and County/City Project Offices are implementing the requirement.

In addition to performing the audit and expressing an opinion on the financial statements, we also make observations with respect to compliance with applicable provisions of state laws and regulations and the loan agreement of the relevant entities, its internal financial control and project management, project performance and the follow-up of previous recommendations during the project implementing process. We found the following issues:

1. Some compartments did not replant trees according to the established design. For example, in Compartment 1 and 2 of Quanwangwu in Changkou Village, Changkou Town of Fuyang City, the majority of replanted trees at the bottom of mountain are Schima superba, but according to the design, the majority types of replanted trees should be evenly distributed into three types. Moreover, in Compartment 16 in Niulanwan of Lianmeng Village, Changhua Town of Lin’an City, the average afforestation density is higher than the average designed density. The actual afforestation density is 42 seedlings/mu (that of bamboo and broad-leaf seedlings is 18 seedlings/mu and 24 seedlings/mu respectively), while the designed afforestation density is 36 seedlings/mu (that of bamboo and broad-leaf seedlings is 14 seedlings/mu and 22 seedlings/mu respectively).

2. Some compartments are not properly tending. For example, Compartment 22 in Shikuang of Gaofeng Village, Moganshan Town, Deqing County is featured by inadequate control over clearing, shrub removal and weeding. Besides, the removed shrubs and weeds have partially covered the replanted seedlings, thus affecting the growth of seedlings, due to the negligence of workers during tending of Compartments 30 to 34 located in Shibanqiao, Daoan Village, Qingshanhu Sub-district of Lin’an City.

3. The year’s afforestation task is not completed according to annual plan. In 2014, the actual afforestation area is 2,024.86 ha. according to self-inspection result of the Provincial Project Office, taking up 69.8% of the planned area (2,899 ha.). Of the completed area, the area of coniferous and broad-leaf forest is 840.73 ha., accounting for 57.60% of the plan; the area of Chinese fir and broad-leaf forest is 594.13 ha., accounting for 82% of the plan; the area of Chinese fir, bamboo and broad-leaf forest is 250 ha., accounting for 66.80% of the plan; the area of chestnut and broad-leaf forest is 247.6 ha., accounting for 100% of the plan; and the area of tea and broad-leaf forest is 92.40 ha., accounting for 100% of the plan. The causes for failure in completing the task are as follows: first, forestry management system has undergone significant adjustments, which affects the implementation of afforestation tasks; second, when the quality fails to meet the design requirements in provincial acceptance inspection, eligibility of reimbursement should only be applied after rectification.

Given the above questions, it is suggested that the Provincial Project Office should mandate related counties to work according to the established design, improve the quality of afforestation and tending, and complete the afforestation task as soon as possible. In 2015, the Provincial Project Office has urged relevant counties to strengthen management of on-site inspection for afforestation and tending, and to pay close attention to the quality and quantity to complete the task.